n 2024, the UAE introduced new corporate tax rules, which also impact businesses operating in Free Zones. Free Zones have always been attractive due to their tax incentives, but with the new corporate tax laws, it’s essential to understand how they apply to what’s called a “Qualifying Free Zone Person.” In this blog, we’ll break down the key concepts in simple terms, with examples, to help you understand.
What is a Qualifying Free Zone Person?
A “Qualifying Free Zone Person” refers to a business entity that operates within a designated Free Zone and meets specific conditions set by the UAE government to enjoy a reduced corporate tax rate. Free Zones are special economic areas where businesses enjoy various benefits like tax exemptions and simplified regulations. However, to benefit from these, the entity must qualify under the new tax rules.
Conditions for Being a Qualifying Free Zone Person
To be considered a Qualifying Free Zone Person, a business must meet the following conditions:
Maintain Adequate Substance
The business must have sufficient operations, employees, and assets in the Free Zone. It can’t just be a shell company.
Derive Qualifying Income
The income must come from activities approved by the Free Zone authorities.
Meet Regulatory Requirements
The business must comply with all regulatory and compliance requirements in the Free Zone.
Not Elect to be Subject to Regular Corporate Tax
The entity must choose to be taxed as a Qualifying Free Zone Person rather than a regular company.
Example
A tech startup in a Free Zone that develops software, has an office, employs staff, and earns revenue from selling its software to clients will likely meet these conditions and qualify for the reduced tax rate.
What is Qualifying Income?
Qualifying Income is the type of income that is eligible for the reduced corporate tax rate for a Qualifying Free Zone Person. This income generally includes revenue from:
- Sales of goods or services to customers outside the UAE.
- Transactions with other Free Zone businesses.
- Certain financial services.
Example
If our tech startup sells software to clients in Europe or other Free Zone companies, that income would likely be considered Qualifying Income.
Corporate Tax Rate on Qualifying Free Zone Person
If a business is recognized as a Qualifying Free Zone Person and earns Qualifying Income, it benefits from a favorable corporate tax rate. For the year 2024, the corporate tax rate on Qualifying Income is 0%. However, any income that doesn’t meet the criteria for Qualifying Income may be subject to the standard corporate tax rate of 9%.
Example
If the tech startup earns AED 1 million from software sales to Europe (Qualifying Income) and AED 200,000 from a UAE mainland client (Non-Qualifying Income), the AED 1 million would be taxed at 0%, and the AED 200,000 could be taxed at 9%.
Taxability of Qualifying Free Zone Person with Group Companies
A common scenario is when a Free Zone business is part of a group of companies, some of which may operate outside the Free Zone. Here’s how the tax rules apply:
Transactions with Group Companies
If a Qualifying Free Zone Person transacts with group companies outside the Free Zone, that income may not be treated as Qualifying Income and could be taxed at 9%.
Group Relief Provisions
Certain provisions allow group companies to offset profits and losses under specific conditions, but careful tax planning is required to ensure compliance.
Example
If our tech startup also has a sister company on the UAE mainland and provides services to it, the income from these services might not be considered Qualifying Income and could be taxed at 9%.
Conclusion
Understanding the concept of a Qualifying Free Zone Person is crucial for businesses operating in UAE Free Zones in 2024. By meeting the necessary conditions and earning Qualifying Income, businesses can enjoy significant tax benefits. However, it’s essential to navigate these rules carefully, especially when dealing with group companies, to avoid unexpected tax liabilities.
If you operate in a Free Zone, make sure you consult with a tax expert to ensure that your business qualifies and that you’re maximizing the benefits available under the new corporate tax regime.
